Stimulus: One Last “High” – Then Disaster

Since 2008, economic policies throughout the rich world have boiled down to one word: stimulus. Interest rates in most countries have been held down well below the level of inflation, while spending programs have pushed national budgets far out of balance.

As in Europe calls rise for further doses of “fiscal stimulus” in spite of that continent’s precarious budget position, while in the United States both fiscal and monetary stimulus is widely canvassed, the global economy languishes. It must surely now be becoming clear: as with most pernicious drugs, repeated usage of stimulus is lessening the stimulative effect while exacerbating the adverse long-term side-effects. As this recession drags on into its fifth year, it is becoming one of diminishing marginal returns.

From the various semi-controlled experiments that have been conducted around the world in the past five years, the efficacy of fiscal and monetary stimulus can be assessed. Public spending itself almost always has a multiplier of less than 1; in other words, when the effect of borrowing the money is factored in, it is generally moderately economically damaging, albeit possibly with a lag. There are exceptions to this, but they are fairly scarce.

If as in Germany after World War II, public spending is used to rebuild damaged infrastructure, it may be devoted to projects of sufficient economic return as to “pay for itself”. If a financial shock such as that of 2008 has damaged the banking system sufficiently as to increase the cost of borrowing for the private sector above its normal levels, then public spending on projects with even a modest positive economic return may also be economically beneficial.